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The demise of employer-sponsored health coverage as a defined benefit is as inevitable as a force of nature, the authors contend.

The paternalistic relationship between business and employee health insurance is on its last legs. The new economy, featuring an older and more transient workforce and competition from foreign firms unburdened by high labor costs, is compelling American companies to rethink health benefits. Three additional forces - the likelihood that insurance premiums will outpace inflation again, the prospect of the removal of ERISA protection, and shareholders’ demands for larger returns on investment - add to the pressure, making the current method of job-based health insurance untenable.

First-dollar coverage is virtually extinct. Workers now pay approximately 25 percent of the cost of premiums formerly paid entirely by their employers. Retirees have been especially hard hit, as many firms have eliminated health benefits for retired workers altogether.

But even with employees shouldering a greater share of the burden, business outlays for health insurance still make up a troublesomely large and rapidly growing percentage of payroll. Between 1970 and 1995, health benefits bulked up from 2.4 percent of total compensation to 7.6 percent. Total health benefit costs to employers with 10 or more workers now average close to $4,000 per active employee. The Congressional Budget Office (CBO) forecasts that costs will double over the next 10 years, and even that rate of growth may be understated.

Over the past four years the premiums for the Federal Employees Health Benefits Program have remained constant, for example, yet the FEHBP has estimated an increase of 8.5 percent for 1998. Private employers face similar increases, now that savings from managed care seem to have reached a plateau. The impact of these costs on the bottom line has jolted firms to the realization that they need to reevaluate their role in the selection, provision and monitoring of health insurance. The inevitable result: a change in the provision of health benefits as we know it, from a defined benefit to a defined contribution form of job-based coverage.

Force No. 1: Rising costs

Estimates vary, but even optimists anticipate that health insurance premiums will grow much faster than inflation for the foreseeable future. The CBO predicts inflation will average 2.8 percent over the next decade while premiums for health coverage rise 5.5 percent per year.

Several factors are involved. For one thing, with so many workers already enrolled in managed care plans, there is little room left to hold down costs by moving employees into lower-cost plans. For another, in pursuing market share, many managed care firms allowed prices to be set by marketing rather than actuarial considerations - an error manifested in depressed earnings. Finally, underinvestment in information systems to track utilization trends has compounded errors in pricing at the same time that new government regulations are squeezing profit margins.

To restore investor confidence, managed care plans are under heavy pressure to raise premium prices. Not surprisingly, firms that assumed managed care had tamed health spending find the anticipated return of inflationary premium pricing very disconcerting.

As waste is squeezed out of the health sector, additional savings become progressively more elusive. Key changes in the relationship between the buyers and sellers of health care regarding ability to control prices are evident as well. The advantages now enjoyed by insurance plans and buyers will steadily erode as health care providers become better organized and more capable of negotiating from positions of strength rather than weakness.

Force No. 2: Legislated change

Regulatory pressure is another crucial factor in the inevitable transformation of employment-based health insurance, with more than a thousand state and federal regulations dictating benefits and coverage on the books today. State-mandated benefits considerably hike the cost of health insurance for most companies that haven’t previously met the mandates. Very large firms with operations in several states may have to offer the extra benefits to all employees, even if they are only required in one of the states.

Recently enacted constraints such as those affecting maternity hospital stays, outpatient mastectomies and the right of plans to exclude physicians with high-cost practice styles seriously hamper management’s ability to contain spending. Even the CBO has acknowledged that such mandates could inhibit managed care plans’ ability to hold down costs and thus boost health care spending. Instead of relying on cost-effective criteria, as originally envisioned, managed care decision making is becoming more politicized. Prudent employers will recognize these threats and act accordingly by moving to a defined contribution strategy.

Employers are also concerned about the deterioration of the Employee Retirement Income Security Act’s shield against costly malpractice litigation and cumbersome state government regulations. Under ERISA, in return for self-insuring, employers are granted exemptions from state efforts to expand access to health care, control growth in health spending and protect workers from plan discrimination. At the national level bills have been introduced that, if passed, will enfeeble ERISA and subject self-insured businesses to intrusive new standards, including granting employees the right to sue their employer for injuries linked to medical malpractice or denials of care.

Force No. 3: Shareholder pressure Shareholder discontent over unsatisfactory earnings has led some businesses to pursue savings by targeting payroll expenditures. But low inflation makes any substitution of fringe benefits for wages both more transparent and harder to sell to labor.

The fact that unemployment is at lowest level in decades and many employers are experiencing a labor shortage puts additional constraints on management’s ability to keep labor costs from rising via the wage/fringe benefit tradeoff. And, in the case of low-income workers, such maneuvers have limited application even under the best of circumstances, since wage levels are already below what society considers sufficient. If anything, the political climate demands that management resort to other means of controlling labor costs.

A decline in managerial flexibility does much to explain why employers have begun to shift increases in health expenditures to workers, both in the form of higher copays and limitations on coverage. This shift in financial responsibility, together with more drastic initiatives to reduce the payroll by downsizing, part-time work and outsourcing, for example, reflects employers’ initial response to the new economy.

As employers try to save by cutting back or eliminating the choice of plans available to employees, their exposure to medical malpractice litigation will increase and necessitate more expenditures. Good risk management principles oblige employers to monitor and assess the quality as well as the price of health services provided to their employees, but this merely adds to the problem.

Not when, but how

Given the financial and regulatory pressures on businesses, the central question is not whether but how employer-sponsored health insurance will change - and what the structure of the new system will be. Apart from a continuing, steady cost shifting from employer to employee, we see three alternatives:

* the adoption of a national health insurance scheme

* the sudden and complete discontinuation of employee health benefits

* a shift from defined benefits to a defined contribution strategy.

Numerous attempts to install a national health insurance scheme have already failed, and the political climate is hardly receptive to another try. And, regardless of how inviting employers may find it, a total abdication from the provision of health benefits is untenable, for two main reasons: First, it would generate costly and unproductive labor-management strife. Second, the subsequent swelling of the uninsured population would incur unwelcome governmental intervention, including a revival of interest in mandatory employer coverage and the subjection of benefit determination to political rather than economic criteria.

Thus, future change predictably will center on medical savings accounts, vouchers or a combination of both. More and more large employers are already insisting on report cards from their managed care plans, both to protect themselves from malpractice litigation in case ERISA protection fails and to prepare for the ultimate transfer of responsibility for the selection of health plans to the employees themselves.

As insurance premiums once again outpace inflation, as firms realize their potential involvement in malpractice litigation, as the compliance cost of government regulation spreads and investors intensify the pressures on management to generate higher returns, employers will be forced to extricate themselves from the provision and oversight of health insurance.

The old system of providing health benefits is moribund. The new economy will finish it off.

Dr. Battistella is a professor of health policy and management and Dr. Burchfield is an assistant professor of health care financial management for the Sloan Graduate Program in Health Services Administration at Cornell University in Ithaca, N.Y.

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